Consider the following information on Stocks I and II: Rate of Return if State O

Question

Consider the following information on Stocks I and II:

Rate of Return if State Occurs


State of Probability of
Economy State of Economy Stock I Stock II
Recession 0.13 -0.15 -0.15
Normal 0.19 0.43 0.33
Irrational exuberance 0.68 0.29 0.29

The market risk premium is 14 percent, and the risk-free rate is 7.7 percent.

For standard deviations: (Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16))

For betas: (Round your answers to 2 decimal places. (e.g., 32.16))

The standard deviation on Stock I's expected return is ???? percent, and the Stock I beta is ????. The standard deviation on Stock II's expected return is ???? percent, and the Stock II beta is ????. Therefore, based on the stocks' systematic risk/beta, Stock is "riskier".

Explanation / Answer

The standard deviation on Stock I= 16.72% expected return on Stock I= 25.94% Stock I beta= (Expected return- Risk free return)/market risk premium = (25.94-7.7)/14= 1.303 The standard deviation on Stock II= 15.17% expected return on Stock II= 24.04% Stock II beta= (24.04-7.7)/14= 1.167 since Beta of stock I is higher, it is more risky.

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